IMF staff conclude visit on second review

Event

On March 7th the IMF released a press statement on its staff visit to Sri Lanka to discuss the country's progress under the Fund's three-year extended fund facility (EFF).

Analysis

We believe that the EFF programme will play an important role in maintaining macroeconomic stability during its implementation (the first review was held in 2016 and the final review is due in April 2019). A key goal of the EFF is to ensure that the sovereign's fiscal position improves and becomes sustainable. We believe that this outcome will be achieved, as the budget deficit is on a declining trend. Whereas the fiscal shortfall was equivalent to 7.4% of GDP in 2015 (the year before the EFF was launched), we forecast that it will narrow to 4.3% in 2019 (the programme ends that year), with the public debt stabilising at around 79% of GDP.

We are in agreement with the IMF that the ongoing drought, which began in October 2016, poses a downside risk to economic growth, inflation and the current-account balance, and have already adjusted our forecasts accordingly. As such, we expect real GDP to grow by only 4.6% in 2017, unchanged from an estimated 4.6% in 2016. The IMF noted that net international reserves had fallen below the Fund's target and that progress on some other benchmarks was uneven (the second review will be completed on April 20th). However, this is unlikely to derail the EFF, as some slippage from the IMF's targets was expected given the difficult overall political and economic situation in Sri Lanka.

Notably, the IMF also urged the Central Bank of Sri Lanka (CBSL) to be ready to tighten monetary policy if inflation or credit growth did not abate significantly. Credit growth has been on a generally decelerating trend since July 2016, slowing from 28.5% year on year in that month to 22% in December. However, the drought has contributed to some price pressures. Both the Colombo consumer price index, which rose by 6.8% in February 2017, and the national consumer price index, up by 6.5% in January, were above the CBSL's recently announced inflation target of 4–6%.

Impact on the forecast

We expect the authorities to make significant (if uneven) progress on structural reforms and reducing the budget deficit while the EFF is being implemented. If consumer price pressures remain high, the CBSL may raise policy interest rates in 2017. Its next monetary policy announcement is on March 24th.